How can investors navigate global equity markets during this volatile period? What does this mean for globalisation and for long-term investors?

Equity portfolio manager Jonathan Knowles, in conversation with investment director Andy Budden in April 2020, shares lessons learnt from previous recessions and crises, and looks ahead towards the market recovery.

 

Andy Budden: Jonathan, how do you compare this crisis to the previous crises you have experienced?

Jonathan Knowles: Three major crises have happened in my career – they were the dot-com bubble burst, the global financial crisis and the current one we are in. What is so striking about the COVID-19 pandemic is the sheer speed of it. It was unprecedented, came almost out of nowhere, and I think it was the second quickest we have experienced, nearly as rapid as the market crash of 1987. Unlike the global financial crisis, where you can lay the blame on some banks lending too much, this is not the case this time around, there is no corporate to take responsibility for this.

 

Andy Budden: It was brutal and fast, and reflected in some ways in the swift actions we have seen from central banks and government as they have remembered the lessons learned from the global financial crisis. What do you think about what the governments and central banks have done so far?

Jonathan Knowles: They have done what everybody wanted them to do, and probably what was necessary, injecting copious liquidity into the system. One of the problems, however, is this crisis comes so close after the previous one. We have not really managed to delever and rebuild from the global financial crisis (GFC) and now we are going into another one. 

In the developed world, governments are rapidly accumulating a lot of debt in the system. For example, the UK could run a fiscal deficit of around 15%  this year. This is not good and there will be a price to pay. 

One consequence is that the private sector will be saving more. And partly because of the global financial crisis, the interest rate policy tool has been exhausted. Interest rates have become negligible in much of the developed world. Having a low base rate in the UK is not particularly healthy.

As we think about these issues and looking at what has been going on in Japan over the past decades, it feels like the world is starting to ‘Japanify’ or some of the developed world are becoming more like Japan.

The unprecedented splurge of money printing has a fancy term called MMT or modern monetary theory. While MMT provides liquidity, one side effect is the displacement of commercial banks. I do not believe that having a government or sovereign entity, as opposed to individual banks, be responsible for the credit creation process is particularly healthy. The risk of moral hazard seems high.

Another problem lies in Europe, where parts of the region have a fixed currency, the euro. The single currency is good for Germany because the euro is cheap for Germany. Germany is very competitive and runs a fiscal and a huge current account surplus. But the situation is not favourable for Italy, for example, because the country already has a large amount of debt and will incur more debt because of COVID, and cannot use currency devaluation to get some relief. Italy might be better off if Germany allowed some debt to be written off in exchange for “a new deal”, but the German taxpayers may not agree to this arrangement. 

Germany's chancellor Angela Merkel rejected the idea of issuing ‘coronabonds’ as a rescue mechanism for Italy. My guess is that the European Central Bank’s system called the EMS (European Monetary System) may be used, but this will only push the problem further down the road. 

I believe there will be a fairly long period of stasis and low growth in Europe. It is possible that the system might break, and Italy might try to exit the EU (European Union). Should that happen, the European banks and the bonds they hold would be clobbered. That is something I am very mindful of. 

1. As at 21 April 2020. Source: The Centre for Policy Studies

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